95th Congress 1 COMMITTEE PRINT
ESOPs and TRASOP
An Explanation for Emplo
Prepared by the Staff of
COMMITTEE ON F
UNITED STATES SE
Russell B. Long, Chairman
Printed for the use of the Committee on Finance
U.S. GOVERNMENT PRINTING OFFICE
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For sale by the Superintendent of Documents, U.S. Government Printing Office
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COMMITTEE OX FINANCE
RUSSELL B. LONG
HERMAN E. TALMADGE, Georgia
ABRAHAM RIBICOFF, Connecticut
HARRY F. BYRD, Jr., Virginia
GAYLORD NELSON, Wisconsin
MIKE GRAVEL, Alaska
LLOYD BENTSEN, Texas
WILLIAM D. HATHAWAY, Maine
FLOYD K. HASKELL, Colorado
SPARK M. MATSUNAGA, Hawaii
DANIEL PATRICK MOYNIHAN, New York
Michael Stern, Staff Director
George W. Pritts, Jr., Minority Counsel
John E. Curtis, Jr., Counsel
CARL T. CURTIS, Nebraska
CLIFFORD P. HANSEN, Wyoming
ROBERT DOLE, Kansas
BOB PACKWOOD, Oregon
WILLIAM V. ROTH, Jr., Delaware
PAUL LAXALT, Nevada
JOHN C. DANFORTH. Missouri
What is an ESOP or TRASOP? 1
How does an ESOP work? 1
How does a TRASOP work? 2
What do employees get as part of the ESOP or TRASOP? 2
What do I own in the ESOP or TRASOP? 3
'When do I receive what I own from the ESOP or TRASOP? 3
What can I do with my shares of employer stock from the ESOP
or TRASOP? 4
How does the ESOP or TRASOP help my employer? 5
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ESOPs and TRASOPs— An Explanation for Employees
Since 1974, the United States Congress has by legislation created two pro-
grams which are designed to give employees the chance to acquire a stock
ownership in their employer. In the Employee Retirement Income Security
Act of 1974, Congress first defined the employee stock ownership plan, or
"ESOP" as it is usually called. In the Tax Reduction Act of 1975, and the
Tax Reform Act of 1976, Congress implemented, and expanded, a different
form of employee stock ownership plan, usually called a "TRASOP." The
ESOP and TRASOP provide stock ownership for each employee without
requiring the employee to spend any of his own money; his investment is the
time and effort he puts into his job to make his employer profitable. Al-
though some ESOPs and TRASOPs permit or require employees to put
money into the ESOP or TRASOP, most provide that the employer will
make all necessary ESOP and TRASOP payments.
What Is An ESOP or TRASOP?
An ESOP or TRASOP is an employee benefit plan which is "qualified"
under the Internal Revenue Code. That is, it has been written in such a way
that it satisfies the requirements of the Internal Revenue Code. As a qualified
plan, the ESOP or TRASOP is required to be operated for the "exclusive
benefit" of participating employees (and their beneficiaries).
How Does an ESOP Work?
The ESOP is designed to acquire stock of an employer for the benefit of
employees. To do so, the ESOP may borrow money from a bank or other
lender (including the employer) . The stock is bought directly from the em-
ployer or from shareholders. When the ESOP borrows money, the employer
guarantees to the lender that the ESOP will repay the loan. Employees are
never required to assume any obligation for the repayment of the money
borrowed by the ESOP. The employer is required to make annual payments
to the ESOP in an amount at least equal to the amount the ESOP must pay
on the money it borrowed. These amounts are then paid by the ESOP to the
lender each year.
The employer is also permitted to make additional payments of cash or
stock to the ESOP each year. The amount of these additional payments is
usually decided by the board of directors of the employer. Because the ESOP
is "qualified," the employer gets a tax deduction for all payments to the
ESOP, up to a maximum limitation established by the Internal Revenue
Code. This tax deduction is available for the required employer payments
and any additional payments, and its effect is to reduce the annual cost of the
ESOP to the employer. Cash put into the ESOP by the employer will be
used primarily to purchase employer stock. In addition, this cash may be in-
vested temporarily in savings accounts or certain other permitted invest-
How Does a TRASOP Work?
An employer which adopts a TRASOP may claim a tax credit against its
Federal income taxes if it makes payments of its stock, or cash which is used
to purchase its stock, to the TRASOP. The amount of the credit which the
employer may claim is limited by law, and part of it may only be claimed
if the employees make payments to the TRASOP which match the pay-
ments made by the employer. Only employers which buy things like
equipment and machinery are generally able to adopt a TRASOP, because
the tax credit is based upon the amount spent for things like capital equip-
ment and machinery.
What Do Employees Get as Part of the ESOP or TRASOP?
Each year, all amounts of cash and employer stock paid by the employer
and employees to the ESOP, and employer stock bought with cash held in
the ESOP, are allocated among the accounts of employees who are partici-
pating in the ESOP. This allocation is usually done on a formula related to
each employee's salary or wages as compared to the salaries or wages of all
other participating employees. Take as an example an employee who earns
$10,000 per year from a company where the total salaries of all participating
employees equal $500,000. That employee's salary or wages is 2 percent of
the total, and so his share of allocations of cash and employer stock under
the ESOP for that year would be 2 percent. If the employer contributed
$100,000 to the ESOP during the year, the employee's share would be $2,000.
A trust will be established (under the ESOP) to hold the cash and em-
ployer stock paid to the ESOP for the benefit of employees (and their
beneficiaries) . It is created by a separate written trust agreement and will be
administered by a trustee. This is done to assure that each employee's interest
in ESOP assets will be protected.
Under a TRASOP, allocations to employees' accounts is done in the same
way as under an ESOP, except that the maximum of any employee's salary
or washes which can be taken into account under a TRASOP is $100,000
What Do I Own in the ESOP or TRASOP?
An ESOP, like most employee benefit plans, is designed to benefit em-
ployees who remain with the employer the longest and contribute most to
the employers success. Therefore, an employee's ownership interest in cash
and employer stock held in the ESOP is usually based on his number of years
of employment with the employer. The employee's ownership interest in the
ESOP is called his 'Vested interest," and the language in the ESOP which
determines his vested interest is called a "vesting schedule." Although there
are manv vesting schedules which may be used by an ESOP, most vesting
schedules are set up so that the longer an employee stays with the employer,
the greater his vested interest becomes.
If an employee terminates employment with the employer for any reason
other than his retirement, or, in some cases his death, his vested interest will
be determined by looking at the vesting schedule and measuring how many
years he has worked for the employer. All cash and employer stock in which
he does not have a vested interest because he has not worked for the em-
ployer for enough years will be treated as a "forfeiture," to which the former
employee will not be entitled. Forfeitures are usually allocated among the
ESOP accounts of the remaining employees on the same basis as employer
payments to the ESOP are allocated.
The vesting schedule applies only where an employee does not end his em-
ployment because of retirement or, in some cases death. If an employee
retires, or. in some cases if he dies, he will immediately have a 100-percent
vested interest in all ESOP assets held for him.
Under a TRASOP, each employee automatically has a 100 percent vested
interest in all amounts which he or his employer contribute to the TRASOP
and which are allocated to his account. Therefore, there are never any for-
feitures under a TRASOP.
When Do I Receive What I Own From the ESOP or TRASOP?
Even though employer stock and cash are usually put into the ESOP or
TRASOP for an employee each year, and put into a special account under
his name, he will normally not be able to actually get any employer stock
and cash from the ESOP or TRASOP until after his employment with the
employer terminates and he ceases to be a participant in the ESOP or
After an employee's participation in the ESOP or TRASOP ends, he (or
his beneficiary) will be eligible to receive a payment of his vested interest.
There are many permissible times and methods for making the payment to
him from the ESOP or TRASOP. For example, it may provide that payment
will be made as soon as possible after an employee's termination of employ-
ment. On the other hand, it may require that any payment be deferred until
some later time, such as the employee's death or his normal retirement date.
However, payment of a former employee's vested benefit must start soon
after his death or attainment of age 65. Payment may be made to a former
employee (or his beneficiary) in a lump sum, or it may be made in
Payment of an employee's vested interest from an ESOP or TRASOP
may be made in cash or employer stock, as determined under the ESOP or
TRASOP, subject to the right of the former participant (or his beneficiary)
to demand a distribution of his benefit in shares of employer stock.
What Can I Do With My Shares of Employer Stock From the ESOP or
Once a former employee (or his beneficiary) gets his shares of employer
stock from the ESOP or TRASOP, they are his property and he can do what
he wants with them. He can vote the shares of employer stock at sharehold-
ers' meetings, receive any dividends paid on the stock by the employer, and he
may keep the stock as long as he wishes.
However, if he wishes to sell or otherwise transfer ownership of the stock
to a third party, he may be required by the terms of the ESOP or TRASOP
to first offer to sell the stock to the employer and the ESOP or TRASOP.
This requirement is called a "right of first refusal" for the employer and the
ESOP or TRASOP; they can exercise this right and purchase the employer
stock at its fair market value. Generally, the price offered by the prospective
buyer or the price at which the stock is publicly traded would establish the
fair market value for the stock. The purpose of this right of first refusal is to
protect the employees or the employer by preventing the stock from
being acquired by outside parties who have no interest in the employer or the
ESOP or TRASOP and to protect the employer whose stock is closely held
from violating any Federal law as a result of having its stock sold when it
does not satisfy certain Government rules.
In addition, at the time the former employee (or his beneficiary) receives
employer stock which is not publicly traded from the ESOP or TRASOP, he
must be given a "put option," the right to demand that the employer buy
his shares of employer stock at their fair market value. In such a case, the
ESOP or TRASOP may provide that the ESOP or TRASOP may buy the
employer stock, although the ESOP or TRASOP may not be required to buy
the stock under the put option. The purpose for including a put option is
to assure that each former employee (or his beneficiary) will have someone
available to buy his shares of employer stock if he wishes to sell.
How Does the ESOP or TRASOP Help My Employer?
The employer benefits primarily from the favorable tax treatment it re-
ceives for all payments made to the ESOP or TRASOP. As explained before,
an employer receives a tax credit for amounts paid to a TRASOP and
a tax deduction for amounts paid to an ESOP. This is very important
when the employer uses the ESOP as a means of borrowing money. In order
to understand how the use of the ESOP to raise money benefits the employer,
a comparison must be made with the usual method of borrowing money.
If an employer which does not have an ESOP wishes to borrow money to
build a new building, expand production, or for any other reason, the em-
ployer would go to a bank to borrow money. When the employer repays the
loan, it will also pay interest on the loan, just like an individual person would
do with a charge account. Although the interest payments would be tax
deductible, the principal payments on the loan would not. This means that
the employer would first figure its taxable income, then pay its income taxes,
and then make its payment on the loan.
The use of an ESOP for this purpose greatly helps the employer because of
the effect it has on the employer's taxes.
In this situation, the ESOP borrows the money from a bank, and signs
a promissory note for the money:
As part of the ESOP loan, the employer gives a written guarantee to the
bank, promising that the ESOP will repay the loan and that each year the
employer will pay to the ESOP enough money to permit the ESOP to make
its annual repayment of the loan :
The ESOP then uses the money from the loan to buy stock from the em-
Each year, the employer makes a tax-deductible payment to the ESOP,
sufficient to let the ESOP make its annual debt repayment to the bank:
The effect of this transaction is to allow the employer to borrow money
from a lender and repay the loan with tax-deductible dollars. Since the prin-
cipal and interest repayments are deducted before the employer's taxable
income is determined, the taxable income is lower than through regular
borrowing and the employer's taxes are reduced.
Since the major portion of the ESOP or TRASOP assets are used to buy
employer stock, the value of each employee's ESOP or TRASOP benefit is
directly tied to the financial success of the employer. Also, the employer, as
a result of the use of an ESOP or TRASOP, benefits because employees
understand that their work performance directly affects the financial suc-
cess of the employer and the value of ESOP or TRASOP assets. After all,
they now own part of the company. This should encourage employees to
work more productively and increase the profitability of their employer.
Another benefit to the employer is that the ESOP provides its shareholders
with a buyer for their stock if they wish to sell. For stockholders of a small
employer, this is a tremendous advantage, and it could also assist the em-
ployer in attracting additional investors.
The adoption of an ESOP or a TRASOP provides benefits iur the em-
ployer, its shareholders and its employees. Our tax laws encourage the estab-
lishment and use of ESOPs and TRASOPs. Congress has passed seven laws in
the past 6 years to encourage employers to consider ESOP and TRASOP.
Will it continue? Senator Russell B. Loner, chairman of the Senate Finance
Committee, has repeatedly stated: "Just as in 1862, when Congress passed
a law to allow Americans who had very little money to own and develop up
to 160 acres of land, we should now give Americans the opportunity to
become owners of our growing frontier of new capital (stock) . The way to
do this is through laws which encourage the development of programs like
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